Friday, July 20, 2007

America awakes from its dream

Around 8 out of 10 Americans don't own a passport but even those with one are unlikely to want to use it.

But this is not for the reason you might think (I'll leave that thought with you!).

The main reason why I believe no American would want to travel abroad this summer is because the value of the US dollar is close to the weakest it has ever been.

As I wrote over two years ago there is good reason to expect the dollar to fall further in value in coming years.

As always, people have two questions about the dollar: how much further can it fall and what does this mean for the rest of the world?

In short, it will keep falling as the Chinese yuan continues to strengthen (and when that will stop nobody knows). And it's not so much what it will mean for the rest of the world but what the rest of the world will mean for the dollar.

If there is a further diminishing appetite for US dollars by countries including China and Japan, then the dollar could fall even more rapidly, sparking a sell-off in US assets and a major crisis across global markets (fingers crossed that won't happen!).

In any case, there is the potential for people to make a LOT of money from the dollar's decline. After all, if you're going to bet, bet big.

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I made two predictions in 2005, one that turned out to be right and the other one that is turning out to be right.

The best prediction I made was to expect the British Pound to strengthen, thus providing a "safe haven" against the likely decline in the dollar.


Up, Up & Away!

Since mid-2005, the Pound has strengthened by almost 20% against the dollar as money has flown to the high yield of British assets (bonds, real estate etc.). Over the same period the FTSE 100 share index has also gained over 30%.

So for investors who had to choose between markets around the world, owning UK shares in Pounds would have been a very wise move (Britsh people have just had to sit back and watch the money roll in... and out to the high street!). For now, this looks like a good strategy to continue for the rest of the year.

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A forecast I made that is beginning to prove correct is a more rapid decline in the dollar overall.


Calm before the storm?

After I predicted a more rapid decline in the dollar in 2005, exactly the opposite proceeded to happen (perhaps some very influential contrarian investors read my blog after all!). For the first year since 2000, the dollar strengthened against the major currencies of the world.

But like most forecasts that are grounded in basic common sense, eventually it prevails and now marks the point where reality begins to "kick in".

Unfortunately, a decline in the dollar is a double-edged sword.

First is the obvious diminished purchasing power of American consumers. The second relates to China.

There has been a lot of pressure on China to strengthen the yuan. While this has happened, albeit gradually, it has come at a time when the dollar has weakened. And since the yuan is still partly pegged to the dollar, the Chinese currency has reflected this weakness, offsetting part of the strength.

So, if the dollar continues to weaken then not only will it hurt the purse of American consumers, US producers will also lose competitiveness to Chinese manufacturers. That's not to mention the fact that a weaker dollar reduces the value of US assets currently held by the Chinese government in the form of US government bonds, which adds to the incentive for the Chinese to diversify into other currencies (British pounds perhaps??). Either way, this does not bode well for the US dollar at all.

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It is not the best time to be an American citizen.

Apart from a deteriorating reputation their country has in certain regions of the world (not mentioning any names!), the value of their home is likely to be flat or declining and they can't afford to go shopping for clothes in Europe.

At some point things will improve but at the moment it's difficult to see this happening any time soon.